Download economics - SchoolRack

MACROECONOMICS
Consumers, Producers,
and the Efficiency of Markets
CHAPTER SEVEN
•1

Welfare economics


How the allocation of resources affects economic
well-being
Willingness to pay

Maximum amount that a buyer will pay for a good
•2
Four Possible Buyers’ Willingness to Pay
•3

Consumer surplus

Amount a buyer is willing to pay for a good
 Minus amount the buyer actually pays for it



Measures the benefit buyers receive from
participating in a market
Closely related to the demand curve
Demand schedule

Derived from the willingness to pay of the possible
buyers
•4
The Demand Schedule and the Demand Curve
Price of Albums
Demand
$100
John’s willingness to pay
Paul’s willingness to pay
80
70
George’s willingness to pay
50
Ringo’s willingness to pay
0
1
2
3
Quantity of Albums
4
The table shows the demand schedule for the buyers in Table 1. The graph shows
the corresponding demand curve. Note that the height of the demand curve reflects
buyers’ willingness to pay.
•5

At any quantity

Price given by the demand curve
 Willingness to pay of the marginal buyer

Demand curve



Reflects buyers’ willingness to pay
Measure consumer surplus
Consumer surplus in a market

Area below the demand curve and above the price
•6
Measuring Consumer Surplus with the Demand Curve
Price of
Albums
(a) Price = $80
John’s consumer
surplus ($20)
$100
Price of
Albums
(b) Price = $70
John’s consumer
surplus ($30)
$100
80
70
80
70
50
50
Paul’s consumer
surplus ($10)
Total consumer
surplus ($40)
Demand
Demand
0
1
2
3
4
Quantity of Albums
0
1
2
3
4
Quantity of Albums
In panel (a), the price of the good is $80, and the consumer surplus is $20. In panel
(b), the price of the good is $70, and the consumer surplus is $40.
•7

A lower price raises consumer surplus


Buyers - always want to pay less
Initial price, P1
 Quantity demanded Q1
 Consumer surplus: area ABC
•© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in
whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
•8
How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P1
Price
Price
P1
(b) Consumer Surplus at Price P2
A
A
Consumer
surplus
Initial
consumer
surplus
C
P1
Additional consumer
surplus to initial consumers
C
B
B
F
P2
Demand
0
Consumer surplus
to new consumers
Q1
Quantity
D
0
Demand
E
Q1
Q2
Quantity
In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area
of the triangle ABC. When the price•©falls
P1Learning.
to P2, All
asRights
in panel (b), the quantity demanded
2011 from
Cengage
Reserved.
May not rises
be copied,
or of the triangle ADF. The increase
rises from Q1 to Q2, and the consumer
surplus
to scanned,
the area
duplicated, in whole or in part, except for
in consumer surplus (area BCFD) occurs
in part
existing consumers now pay less (area
use as permitted
in abecause
license distributed
with a certainenter
productthe
or service
or at the lower price (area CEF).
BCED) and in part because new consumers
market
otherwise on a password-protected website
for classroom use.
•9

A lower price raises consumer surplus

New, lower price, P2
 Greater quantity demanded, Q2
 New buyers
 Increase in consumer surplus from area ABC
 From initial buyers, add area BCDE
 From new buyers, add area CEF
•10

Consumer surplus

Benefit that buyers receive from a good
 As the buyers themselves perceive it
Good measure of economic well-being
 Exception: Illegal drugs

 Drug addicts
 Willing to pay a high price for heroin
 Society’s standpoint
 Drug addicts don’t get a large benefit from being able to
buy heroin at a low price
•© 2011 Cengage Learning. All Rights
Reserved. May not be copied, scanned, or
duplicated, in whole or in part, except for
use as permitted in a license distributed
with a certain product or service or
otherwise on a password-protected website
for classroom use.
•11

Cost



Value of everything a seller must give up to produce
a good
Measure of willingness to sell
Producer surplus

Amount a seller is paid for a good minus the seller’s
cost of providing it
•© 2011 Cengage Learning. All Rights
Reserved. May not be copied, scanned, or
duplicated, in whole or in part, except for
use as permitted in a license distributed
with a certain product or service or
otherwise on a password-protected website
for classroom use.
•12
The Costs of Four Possible Sellers
•13

Producer surplus


Supply schedule


Closely related to the supply curve
Derived from the costs of the suppliers
At any quantity

Price given by the supply curve shows the cost of the
marginal seller
•14
The Supply Schedule and the Supply Curve
Price of House Painting
Supply
Mary’s cost
$900
Frida’s cost
800
Georgia’s cost
600
500
0
Grandma’s cost
1
2
3
4
Quantity of Houses Painted
The table shows the supply schedule for the sellers in Table 2. The graph shows the
corresponding supply curve. Note that the height of the supply curve reflects sellers’ costs.
•15

Supply curve



Reflects sellers’ costs
Measure producer surplus
Producer surplus in a market

Area below the price and above the supply curve
•16
Measuring Producer Surplus with the Supply Curve
(a) Price = $600
(b) Price = $800
Price of House Painting
Price of House Painting
Supply
Supply
$900
$900
800
800
600
500
600
500
Grandma’s producer
surplus ($100)
Total producer
surplus ($500)
Georgia’s producer
surplus ($200)
Grandma’s producer
surplus ($300)
0
1
2
3
4
Quantity of Houses Painted
0
1
2
3
4
Quantity of Houses Painted
In panel (a), the price of the good is $600, and the producer surplus is $100. In panel (b), the
price of the good is $800, and the producer surplus is $500.
•17

A higher price raises producer surplus


Sellers - want to receive a higher price
Initial price, P1
 Quantity supplied, Q1
 Producer surplus, area ABC
•18
How the Price Affects Producer Surplus
(a) Producer Surplus At Price P1
(b) Producer Surplus At Price P2
Price
Price
Supply
P2
P1
B
Producer
surplus
P1
C
A
0
Additional producer
surplus to initial producers
D
E
Supply
F
B
C
Initial
producer
surplus
Producer surplus
to new producers
A
Q1
Quantity
0
Q1
Q2 Quantity
In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of
the triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises
from Q1 to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in
producer surplus (area BCFD) occurs in part because existing producers now receive more(area
BCED) and in part because new producers enter the market at the higher price (area CEF).
•19

A higher price raises producer surplus

New, higher price, P2
 Greater quantity supplied, Q2
 New producers
 Increase in producer surplus from area ABC
 From initial suppliers, add area BCDE
 From new suppliers, add area CEF
•20

The benevolent social planner



All-knowing, all-powerful, well-intentioned dictator
Wants to maximize the economic well-being of
everyone in society
Economic well-being of a society

Total surplus = Sum of consumer and producer
surplus
•21

Total surplus = Consumer surplus + Producer
surplus
 Consumer surplus = Value to buyers – Amount paid by
buyers
 Producer surplus = Amount received by sellers – Cost
to sellers
 Amount paid by buyers = Amount received by sellers

Total surplus = Value to buyers – Cost to
sellers
•22

Efficiency



Property of a resource allocation
Maximizing the total surplus received by all
members of society
Equality

Property of distributing economic prosperity
uniformly among the members of society
•23

Gains from trade in a market


The question of efficiency


Like a pie to be shared among the market
participants
Whether the pie is as big as possible
The question of equality


How the pie is sliced
How the portions are distributed among members of
society
•24

Market outcomes
Free markets allocate the supply of goods to the
buyers who value them most highly
1.

2.
Measured by their willingness to pay
Free markets allocate the demand for goods to the
sellers who can produce them at the least cost
•25
Consumer and Producer Surplus in the Market Equilibrium
Price
Supply
A
D
Consumer
Equilibrium surplus
price
Producer
E
surplus
B
C
Demand
0
Equilibrium
Quantity
quantity
Total surplus—the sum of consumer and producer surplus—is the area between the
supply and demand curves up to the equilibrium quantity
•26

Market outcomes

Social planner
 Cannot increase economic well-being by
 Changing the allocation of consumption among buyers
 Changing the allocation of production among sellers
 Cannot rise total economic well-being by
 Increasing or decreasing the quantity of the good
•27
•
Market outcomes
3.

Market equilibrium


Free markets produce the quantity of goods that
maximizes the sum of consumer and producer
surplus
Efficient allocation of resources
The benevolent social planner

“Laissez faire” = “allow them to do”
•28
The Efficiency of the Equilibrium Quantity
Supply
Price
Cost
to
sellers
Value
to
buyers
Value
to buyers
Cost
to sellers
0
Q1
Equilibrium
quantity
Q2
Demand
Quantity
Value to buyers is greater
Value to buyers is less
than cost to sellers
than cost to sellers
At quantities less than the equilibrium quantity, such as Q1, the value to buyers exceeds the cost
to sellers. At quantities greater than the equilibrium quantity, such as Q2, the cost to sellers
exceeds the value to buyers. Therefore, the market equilibrium maximizes the sum of producer
and consumer surplus.
•29

Adam Smith’s invisible hand
Takes all the information about buyers and sellers
into account
 Guides everyone in the market to the best outcome
 Economic efficiency


Free markets = best way to organize economic
activity
•30

“How a mother’s love helped save two lives”
Ms. Stevens - her son needed a kidney transplant
 The mother’s kidney was not compatible
 Donated one of her kidneys to a stranger
 Her son was moved to the top of the kidney waiting
list

•31

Questions
Trade a kidney for a kidney?
 Trade a kidney for an expensive, experimental
cancer treatment?
 Exchange her kidney for free tuition for her son?
 Sell her kidney for cash?

•32

Public policy


Market for organs


Illegal for people to sell their organs
Government has imposed a price ceiling of zero Shortage of the good
Large benefits to allowing a free market in
organs

People are born with two kidneys
 Usually need only one

Few people – no working kidney
•33

Current situation



Typical patient - wait several years for a kidney
transplant
Every year - thousands of people die because a
kidney cannot be found
Current system: is it fair?


Some people - extra kidney they don’t really need
Others - dying to get one
•34

Allow for kidney market

Balance supply and demand
 Sellers – extra cash in their pockets
 Buyers – live
 No more shortage of kidneys
 Efficient allocation of resources

Critics: worry about fairness
 Benefit the rich at the expense of the poor
•35

Forces of supply and demand


Allocate resources efficiently
Several assumptions about how markets work
1.
2.
Markets are perfectly competitive
Outcome in a market matters only to the buyers
and sellers in that market
•36

When these assumptions do not hold


“Market equilibrium is efficient” may no longer be
true
In the world, competition is far from perfect

Market power
 A single buyer or seller (small group)
 Control market prices
 Markets are inefficient
•37

In the world

Decisions of buyers and sellers
 Affect people who are not participants in the market at
all

Externalities
 Cause welfare in a market to depend on more than just
the value to the buyers and the cost to the sellers

Inefficient equilibrium
 From the standpoint of society as a whole
•38

Market failure
E.g.: market power and externalities
 The inability of some unregulated markets to
allocate resources efficiently
 Public policy

 Can potentially remedy the problem and increase
economic efficiency
•39